It’s time for Asia to look beyond the dollar
Winner of the 2001 Nobel prize for economics, Joseph Stiglitz is a trenchant critic of the “market fundamentalism” of the International Monetary Fund. In an interview in New Delhi recently, he discusses some of the ideas in his latest book, Making Globalisation Work (Viking, 2006), including the need for an alt ernative to the dollar reserve system.
Siddharth Varadarajan
The Hindu, 28 December
Both Thomas Friedman and you start your books in Bangalore but he discovers the world is flat while you discover the path to globalisation is full of potholes.
The amusing thing is that Friedman went to Bangalore and visited Infosys a month after I did. I heard exactly the same stories and we were both struck in some of the same ways. But I say that not only is the world not flat but in many ways it’s getting less flat. Some countries are doing much better — India and China are growing at historically unprecedented rates, and this has a lot to do with globalisation — but Africa doesn’t have either the education or resources to take advantage of these new technologies. As a result, disparities are actually increasing. The Uruguay trade agreement was so unfair it made the poorest countries in the world worse off.
In your book, you also argue that the rules of the game — the financial architecture, corporate domination, IPR regimes — are all making the world less flat, more unequal. Can you give us an
example?
One manifestation is that for the first time we have a global monopoly in an industry that is the pivotal industry, IT — Microsoft, Intel. This may not be a permanent monopoly but clearly we have a dominant firm that is dominant for a considerable number of years and gained its dominance through anti-competitive practices. Judges in the U.S. and Europe have ruled it engaged in anti-competitive practices. In the case of Standard Oil, there was a monopoly, so they broke it up. Here, they don’t know what to do, so they’ve allowed it to continue, and it has continued to engage in anti-competitive practices.
You mentioned India as a success. How sustainable is its current growth?
If you look at the sector where India has grown, it’s been IT. And the success of IT is largely based on heavy government investments in the past on education, the IITs, science. These are investments made over 50-100 years that have started to pay fruit.
What about public investments in heavy industry — the fact that India was able to reach a critical level in manufacturing?
I haven’t studied the Indian economy that thoroughly but my impression is that the real engine has been the IT sector and that’s related to education and to the good fortune of the world changing in ways that suddenly gave new opportunities India was able to seize. There are many things which facilitated that — over-investment in fibre optics in the U.S., for example, brought down telecommunication costs. Some telecom policies of liberalisation meant the cost of communications were lower. And there were things the government could have done that would have messed things up. For example, in Mexico, the cost of telecommunications is very high because they have a monopoly provider and monopoly providers raise the price. They privatised, but not in the right way. So India did a number of things in the right way, some over a long period, some in the short run, and the world changed in a way that was just right for India.
There is a debate on the sustainability of India’s growth rate without the manufacturing sector also playing a larger role. Economists are talking about the need for a course correction.
I think the view that you need to have a particular sectoral composition is wrong. The U.S., for example, is now two-thirds services, and manufacturing is down to 11 per cent.
But the share has come down after 100 years of growth. Recent research on employment elasticities suggests India's over-dependence on IT and services may not be the best strategy. Can a country of India's size develop without manufacturing being a major contributor?
The view that everybody has to go through the same historical sequence is wrong. The world today is different from what it was 50 years ago, there was no IT then, and there is no particular reason you have to go through the same sequence. It may be that for India it is appropriate to skip the manufacturing stage, that China may have a comparative advantage in manufacturing. I'm not saying that's true, but there is no a priori reason to stress manufacturing. We should ask what the comparative advantages are, and, from a global perspective, whether one can have sustained growth based on a service sector economy. The answer is clearly yes. Can you have heavy exports related to services? Again, the answer is yes. Creating jobs is an important issue, but it may be that, for instance, part of the strategy for creating jobs will involve expanding tourism, which is a very labour intensive service sector. The problem in manufacturing is that modern technology doesn't use much labour. Most modern technologies in manufacturing are very capital intensive.
India now has an employment guarantee scheme to provide income support for the poor. How do you rate such welfare schemes against the objection that they boost fiscal deficits?
Manmohan Singh has once again started talking about capital account convertibility for India. What would your advice to him be?
I share the sentiments of those who have very strong reservations. The overwhelming evidence is that convertibility doesn't bring faster economic growth. It brings more instability. You can't build factories with money that's going to come in and out overnight but this money can wreak havoc on an economy. You have to look at the balance of benefits and costs. The costs are clear and the evidence is strong, the benefits are weak and the evidence in favour of these benefits is very weak.
Privatisation & land acquisition
In India today, there is no political support for privatisation but many reform-oriented economists consider this a bad thing. How do you see this issue?
It depends very critically on what is being privatised and how things are being privatised. When you privatise a natural monopoly before you put in a regulatory structure, the firm is more interested in raising prices. Second, based on Latin American evidence, privatisations do not, in general, lead to greater efficiency. It is true that if you artificially tie the hands of an industry by restricting investment — and IMF accounting often makes it difficult to engage in investment because it treats borrowing by the government for a public enterprise in the same manner as borrowing for social services or anything else — and then you privatise and release the artificially imposed investment constraint, privatisation can then sometimes increase efficiency. But the answer to that is to get rid of the artificial investment constraint. The benefits come from release of that constraint, not privatisation. Third, privatisation is very problematic in oil, mining sectors, etc., where the resources of a country have been turned over at bargain-basement prices.
In India, most of our privatisations involved serious valuation problems.
Revenue is an issue. One of the countries market fundamentalists often cite is Chile. I once asked the President of Chile his opinion and he said, "We were successful because we didn't follow the Washington Consensus." He went on to point out they only privatised half the copper mines. The government mines are just as efficient as the private ones but bring in 10 times more revenue for the government. So in terms of generating revenue that can be used for public purposes, privatisation was a big mistake. A lot depends on the pace and manner of privatisation but the evidence is that it is extraordinarily difficult to do it well. And there are some theoretical problems why this is so.
Agency problems?
Broadly speaking, yes. You talk about corruption and one of the arguments for privatisation is often that governments run things inefficiently and corruptly. But when you privatise, the incentives for corruption are even greater. The incentive is to try and get it at bargain-basement prices. Because you capitalise all future returns.
The rent seeking associated with the life of the asset being privatised is compressed at one moment in time.
Yes, and because it is compressed at one moment, the incentive to cheat becomes all the greater. The willingness to go beyond bounds of normal behaviour becomes all the greater. So privatisation doesn't solve the agency problem, and by compressing it, it may exacerbate it.
One of the paradoxes of market `reform' in India is that if you are a big company and are planning to set up a factory, you want a free market to buy equipment and hire workers but expect government intervention to acquire land. Can this be justified on the basis of first principles?
There is a general view that where there are large externalities — urban renewal programmes, for instance — there may be grounds for government to try and buy land and help renew a city or part of a city. But the dangers of doing this when there is a single firm without externalities are enormous. This is because the government often uses the right of eminent domain with compensation below market price.
So future rents are shared between the firm for whom land is acquired and the original land owners in a very unequal way...
That's right, exactly, and that's why these firms turn to the government. In general, there is a price at which people would sell their land. The reason these firms ask the government to do it is because they don't want to pay that market price. So once you get into that mindset, it becomes a very dangerous precedent.
The argument made in India is that land holdings are fragmented, that there is no land market.
You have a problem when land is fragmented, or there are land market inefficiencies, and difficulties in getting clear title. Markets might be so poorly developed that businesses can't acquire land and that becomes an impediment to development. Of course, the right answer is to solve the problem of the land market and not to solve it for this particular person by taking over that particular piece of property!
Asia and the dollar's decline
One of the most interesting arguments in your book is where you talk about a new global reserve system. Given Washington's resistance to such ideas in the past, including to Japan's proposal for an Asian Monetary Fund, how feasible is this, especially since there's a link between the role of the dollar and the global power, the seigniorage, the U.S. derives from this?
The system of seigniorage to the U.S. is inequitable. The foreign aid from developing countries to the U.S. is greater than the foreign aid the U.S. gives and the system has a downward bias in aggregate demand. This is a very peculiar and unstable system where the only thing keeping global demand strong is if the richest country in the world consumes beyond its means. As the U.S. gets more and indebted, confidence in the dollar erodes, and it no longer is a good store of value.
Rather than holding dollars as reserves, countries should hold an internationally created `bancor' or global greenback — a `money' that's used in reserves and is convertible into ordinary currency. The idea is similar to special drawing rights but the SDR system is periodical and subject to veto by the U.S., which mistakenly thinks it gains from the system. I argue it doesn't. It gains seigniorage, but it loses stability. My proposal is for a regular rather than periodic system and one that is automatic and rule based.
The current dollar system is fraying. We might go to a two-currency reserve system, which simply maintains the problem and divides it between the U.S. and Europe. This would be better than the current system but is not a good solution. As countries recognise the problem, there will be demand for change. There are two reasons why I think it is politically feasible, besides the fact that the current system is crumbling. First, the major source of savings in the world today is Asia and a lot of Asian countries are asking, "Why are we subsidising the U.S.?" This is a weird system! The Chiang Mai initiative was a framework of exchanging reserves, which is really basically the same idea. Rather than using the U.S. dollar as a reserve, we use each other, and all you have to say is that if we're using each other, we'll create a currency. One of the proposals I talk about in my book is to make this an open architecture. We'll have a cooperative agreement, and anybody who wants to join can do so, and there will be a rule that over time you have to put more and more of your reserves in the members of the club. That will put a strong incentive for countries outside the club to join, namely the U.S.
For this to work, Asia will have to take the lead.
Very much. That is the core thing. A new reserve system is not going to happen overnight but it's getting discussed.
Can Asian countries push the debate by pricing trade, especially natural resources like oil, in currencies other than dollars? Would that provide the critical mass for us to move in the direction of a new system?
It's already happening. The U.S. would like to keep the dollar as the reserve currency, and all the seigniorage. But as it realises it is fighting a losing battle — that people are moving out of the dollar — it will not be able to keep the dollar as the sole reserve currency. So the U.S. may realise that it would benefit from the greater stability that a new system would bring.
Siddharth Varadarajan
The Hindu, 28 December
Both Thomas Friedman and you start your books in Bangalore but he discovers the world is flat while you discover the path to globalisation is full of potholes.
The amusing thing is that Friedman went to Bangalore and visited Infosys a month after I did. I heard exactly the same stories and we were both struck in some of the same ways. But I say that not only is the world not flat but in many ways it’s getting less flat. Some countries are doing much better — India and China are growing at historically unprecedented rates, and this has a lot to do with globalisation — but Africa doesn’t have either the education or resources to take advantage of these new technologies. As a result, disparities are actually increasing. The Uruguay trade agreement was so unfair it made the poorest countries in the world worse off.
In your book, you also argue that the rules of the game — the financial architecture, corporate domination, IPR regimes — are all making the world less flat, more unequal. Can you give us an
example?
One manifestation is that for the first time we have a global monopoly in an industry that is the pivotal industry, IT — Microsoft, Intel. This may not be a permanent monopoly but clearly we have a dominant firm that is dominant for a considerable number of years and gained its dominance through anti-competitive practices. Judges in the U.S. and Europe have ruled it engaged in anti-competitive practices. In the case of Standard Oil, there was a monopoly, so they broke it up. Here, they don’t know what to do, so they’ve allowed it to continue, and it has continued to engage in anti-competitive practices.
You mentioned India as a success. How sustainable is its current growth?
If you look at the sector where India has grown, it’s been IT. And the success of IT is largely based on heavy government investments in the past on education, the IITs, science. These are investments made over 50-100 years that have started to pay fruit.
What about public investments in heavy industry — the fact that India was able to reach a critical level in manufacturing?
I haven’t studied the Indian economy that thoroughly but my impression is that the real engine has been the IT sector and that’s related to education and to the good fortune of the world changing in ways that suddenly gave new opportunities India was able to seize. There are many things which facilitated that — over-investment in fibre optics in the U.S., for example, brought down telecommunication costs. Some telecom policies of liberalisation meant the cost of communications were lower. And there were things the government could have done that would have messed things up. For example, in Mexico, the cost of telecommunications is very high because they have a monopoly provider and monopoly providers raise the price. They privatised, but not in the right way. So India did a number of things in the right way, some over a long period, some in the short run, and the world changed in a way that was just right for India.
There is a debate on the sustainability of India’s growth rate without the manufacturing sector also playing a larger role. Economists are talking about the need for a course correction.
I think the view that you need to have a particular sectoral composition is wrong. The U.S., for example, is now two-thirds services, and manufacturing is down to 11 per cent.
But the share has come down after 100 years of growth. Recent research on employment elasticities suggests India's over-dependence on IT and services may not be the best strategy. Can a country of India's size develop without manufacturing being a major contributor?
The view that everybody has to go through the same historical sequence is wrong. The world today is different from what it was 50 years ago, there was no IT then, and there is no particular reason you have to go through the same sequence. It may be that for India it is appropriate to skip the manufacturing stage, that China may have a comparative advantage in manufacturing. I'm not saying that's true, but there is no a priori reason to stress manufacturing. We should ask what the comparative advantages are, and, from a global perspective, whether one can have sustained growth based on a service sector economy. The answer is clearly yes. Can you have heavy exports related to services? Again, the answer is yes. Creating jobs is an important issue, but it may be that, for instance, part of the strategy for creating jobs will involve expanding tourism, which is a very labour intensive service sector. The problem in manufacturing is that modern technology doesn't use much labour. Most modern technologies in manufacturing are very capital intensive.
India now has an employment guarantee scheme to provide income support for the poor. How do you rate such welfare schemes against the objection that they boost fiscal deficits?
I think they're absolutely necessary for long-term sustainable growth. Latin America has shown what happens with high degrees of inequality. You get political and social instability. You have high crime rates and an environment that's not good for investment. What's also very clear is that trickle-down economics doesn't work. It hasn't worked anywhere. It hasn't worked in the United States. Even though GDP is going up, most Americans are worse off today than they were six years ago.
In fact, a survey just came out here — the Focus report on the status of children under six — which shows that despite six per cent growth for nearly a decade, the nutritional status of Indian children hasn't improved.
Yes, I just saw that and these are very, very disturbing numbers. Nutrition is a more reliable indicator than income because it is a physically observed characteristic. Growth is not trickling down so doing something about this exclusion is absolutely necessary. Even if there was just a transfer of income, this would be a benefit. But if these schemes are well-designed, they can be used to create infrastructure in the rural sector as well.Manmohan Singh has once again started talking about capital account convertibility for India. What would your advice to him be?
I share the sentiments of those who have very strong reservations. The overwhelming evidence is that convertibility doesn't bring faster economic growth. It brings more instability. You can't build factories with money that's going to come in and out overnight but this money can wreak havoc on an economy. You have to look at the balance of benefits and costs. The costs are clear and the evidence is strong, the benefits are weak and the evidence in favour of these benefits is very weak.
Privatisation & land acquisition
In India today, there is no political support for privatisation but many reform-oriented economists consider this a bad thing. How do you see this issue?
It depends very critically on what is being privatised and how things are being privatised. When you privatise a natural monopoly before you put in a regulatory structure, the firm is more interested in raising prices. Second, based on Latin American evidence, privatisations do not, in general, lead to greater efficiency. It is true that if you artificially tie the hands of an industry by restricting investment — and IMF accounting often makes it difficult to engage in investment because it treats borrowing by the government for a public enterprise in the same manner as borrowing for social services or anything else — and then you privatise and release the artificially imposed investment constraint, privatisation can then sometimes increase efficiency. But the answer to that is to get rid of the artificial investment constraint. The benefits come from release of that constraint, not privatisation. Third, privatisation is very problematic in oil, mining sectors, etc., where the resources of a country have been turned over at bargain-basement prices.
In India, most of our privatisations involved serious valuation problems.
Revenue is an issue. One of the countries market fundamentalists often cite is Chile. I once asked the President of Chile his opinion and he said, "We were successful because we didn't follow the Washington Consensus." He went on to point out they only privatised half the copper mines. The government mines are just as efficient as the private ones but bring in 10 times more revenue for the government. So in terms of generating revenue that can be used for public purposes, privatisation was a big mistake. A lot depends on the pace and manner of privatisation but the evidence is that it is extraordinarily difficult to do it well. And there are some theoretical problems why this is so.
Agency problems?
Broadly speaking, yes. You talk about corruption and one of the arguments for privatisation is often that governments run things inefficiently and corruptly. But when you privatise, the incentives for corruption are even greater. The incentive is to try and get it at bargain-basement prices. Because you capitalise all future returns.
The rent seeking associated with the life of the asset being privatised is compressed at one moment in time.
Yes, and because it is compressed at one moment, the incentive to cheat becomes all the greater. The willingness to go beyond bounds of normal behaviour becomes all the greater. So privatisation doesn't solve the agency problem, and by compressing it, it may exacerbate it.
One of the paradoxes of market `reform' in India is that if you are a big company and are planning to set up a factory, you want a free market to buy equipment and hire workers but expect government intervention to acquire land. Can this be justified on the basis of first principles?
There is a general view that where there are large externalities — urban renewal programmes, for instance — there may be grounds for government to try and buy land and help renew a city or part of a city. But the dangers of doing this when there is a single firm without externalities are enormous. This is because the government often uses the right of eminent domain with compensation below market price.
So future rents are shared between the firm for whom land is acquired and the original land owners in a very unequal way...
That's right, exactly, and that's why these firms turn to the government. In general, there is a price at which people would sell their land. The reason these firms ask the government to do it is because they don't want to pay that market price. So once you get into that mindset, it becomes a very dangerous precedent.
The argument made in India is that land holdings are fragmented, that there is no land market.
You have a problem when land is fragmented, or there are land market inefficiencies, and difficulties in getting clear title. Markets might be so poorly developed that businesses can't acquire land and that becomes an impediment to development. Of course, the right answer is to solve the problem of the land market and not to solve it for this particular person by taking over that particular piece of property!
Asia and the dollar's decline
One of the most interesting arguments in your book is where you talk about a new global reserve system. Given Washington's resistance to such ideas in the past, including to Japan's proposal for an Asian Monetary Fund, how feasible is this, especially since there's a link between the role of the dollar and the global power, the seigniorage, the U.S. derives from this?
The system of seigniorage to the U.S. is inequitable. The foreign aid from developing countries to the U.S. is greater than the foreign aid the U.S. gives and the system has a downward bias in aggregate demand. This is a very peculiar and unstable system where the only thing keeping global demand strong is if the richest country in the world consumes beyond its means. As the U.S. gets more and indebted, confidence in the dollar erodes, and it no longer is a good store of value.
Rather than holding dollars as reserves, countries should hold an internationally created `bancor' or global greenback — a `money' that's used in reserves and is convertible into ordinary currency. The idea is similar to special drawing rights but the SDR system is periodical and subject to veto by the U.S., which mistakenly thinks it gains from the system. I argue it doesn't. It gains seigniorage, but it loses stability. My proposal is for a regular rather than periodic system and one that is automatic and rule based.
The current dollar system is fraying. We might go to a two-currency reserve system, which simply maintains the problem and divides it between the U.S. and Europe. This would be better than the current system but is not a good solution. As countries recognise the problem, there will be demand for change. There are two reasons why I think it is politically feasible, besides the fact that the current system is crumbling. First, the major source of savings in the world today is Asia and a lot of Asian countries are asking, "Why are we subsidising the U.S.?" This is a weird system! The Chiang Mai initiative was a framework of exchanging reserves, which is really basically the same idea. Rather than using the U.S. dollar as a reserve, we use each other, and all you have to say is that if we're using each other, we'll create a currency. One of the proposals I talk about in my book is to make this an open architecture. We'll have a cooperative agreement, and anybody who wants to join can do so, and there will be a rule that over time you have to put more and more of your reserves in the members of the club. That will put a strong incentive for countries outside the club to join, namely the U.S.
For this to work, Asia will have to take the lead.
Very much. That is the core thing. A new reserve system is not going to happen overnight but it's getting discussed.
Can Asian countries push the debate by pricing trade, especially natural resources like oil, in currencies other than dollars? Would that provide the critical mass for us to move in the direction of a new system?
It's already happening. The U.S. would like to keep the dollar as the reserve currency, and all the seigniorage. But as it realises it is fighting a losing battle — that people are moving out of the dollar — it will not be able to keep the dollar as the sole reserve currency. So the U.S. may realise that it would benefit from the greater stability that a new system would bring.
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